Chapter 13 Bankruptcy Explained

By Stephanie Dube Dwilson

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If you've gotten yourself into deep debt and there's no way you can repay it, you might consider declaring bankruptcy. Chapter 13 is a type of bankruptcy in which you agree to make payments on your debt over a period of time, in exchange for getting to keep some of your property. The bankruptcy may also involve combining your debts into one lump sum, making it easier to pay.

Chapter 13 vs. Chapter 7

People typically may choose either Chapter 13 or Chapter 7 bankruptcy. Although Chapter 7 bankruptcy is open to anyone, only people with a regular income may file Chapter 13 bankruptcy. In a Chapter 7 bankruptcy, assets are liquidated and sold to pay off the debt owed. In a Chapter 13 bankruptcy, the trustee, who administers your case and oversees your progress, puts together a plan that allows you to make payments over the course of three to five years.

Eligibility for Chapter 13

Businesses aren't eligible for Chapter 13 bankruptcy. However, you may qualify if you have a regular income, even if you are self-employed. As of 2014, your secured debt, which means debt secured by collateral that a creditor can reclaim if you default, such as a car loan, must be less than $1,149,525 to qualify. Unsecured debts such as consumer credit cards must be less than $383,175. If you've recently filed a bankruptcy petition, you may be ineligible to file for Chapter 13 bankruptcy.

Advantages and Disadvantages

Because Chapter 7 bankruptcy results in liquidating property to help pay off debt, if you're behind on house or car payments but want to keep that property, you may want to choose Chapter 13 bankruptcy if you're eligible. The main disadvantage of Chapter 13 is that it lasts longer, up to five years, compared to Chapter 7 which can be discharged in just a few months. Any new debt you want to incur during the bankruptcy, such as a new car, must be approved by the trustee who's overseeing your bankruptcy case. The fees for Chapter 13 are also higher.

How it Works

You file a Chapter 13 petition with the bankruptcy court in your state, including statements detailing assets and liabilities, income and expenditures, and other financial information. A monthly income statement is also filed to show you have enough income after all your basic necessities are covered, such as rent and utilities, to make monthly payments on your debt. The court organizes your debt hierarchically. For example, taxes you owe receive higher priority and must be paid in full. In contrast, unsecured debt, such as credit card charges, is at the bottom of the priority list. Your trustee can negotiate the total to be paid on these debts. The court then consolidates all of your debts so you only make one monthly payment directly to the trustee. The amount of your payment is based on what's needed to complete the repayment plan within three to five years.

Hardship Discharge

If you make your monthly payments on time, some or all of your debt will be paid off in three to five years and your bankruptcy discharged. If you fail to make payments, the case may be converted to Chapter 7 and your assets liquidated instead. If a situation arises that is outside of your control and makes it impossible for you to make your payments, you may be able to get a hardship discharge. A devastating injury or illness might qualify for a hardship discharge.